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Sukuk offerings witness 39% slowdown this year

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Points of Essence:

  • The global credit crunch has caused the demands for Sukuk issuance in 2008  to dwindle as the liquidity dried up, with a decline rate of more than 39% this year to rest at only $14 billion compared with $23 billion last year. The recent exposure by AAIOFI on questionable Shariah compliance issues affecting some sukuk issuance has certainly no bearing on this downfall.

Tight liquidity in the global and regional markets is responsible for the slowdown in the issuance of sukuk in 2008, which has seen a decline of more than 39 per cent in the first eight months of this year to $14 billion (Dh51.42bn), as opposed to $23bn registered in the same period last year.

Sukuk experts in the region have told Emirates Business that contrary to what has appeared in a section of the financial media, blaming comments about the Shariah-compliance of some sukuk by the Accounting and Auditing Organisation for Islamic Financial Institutions, it is the lack of liquidity – which has impacted other financial instruments as well – that is largely responsible for the lower number of sukuk.

“We need to be careful about reports attributing the fall in sukuk secondary market prices to the organisation’s recent pronouncements,” said Yavar Moini, Executive Director for Global Capital Markets at Morgan Stanley.

“The organisation’s standards, whilst there to be respected, are not binding on any Islamic financial institution outside Bahrain. For example, all sukuk accounting is as per IFRS and not the organisation standards,” he said. “Subsequent to the February pronouncement [by the organisation], there have been significant sukuk deals brought to market. These include Nakheel (Dh3.6bn), Aldar (Dh3.7bn), Tamweel (Dh1.1bn) and Tabreed (Dh1.7bn). Therefore, deals continue to be made.”

Sheikh Muhammad Taqi Usmani, Chairperson of the organisation’s advisory board, had in comments made late last year declared 85 per cent of sukuk to be un-Islamic. Later, the organisation issued a statement saying any financial product with a buyback clause was un-Islamic because this effectively eliminated the risk-sharing aspect of the investment, a necessary part of Shariah-compliance.

The organisation also declared that, in order to be considered Islamic, sukuk must be asset-backed, and not merely asset-based. It has come under a lot of heat recently owing to the unclear nature of the comments.

“Until we get clarity from the Islamic banking institutions and from the organisation itself, the market is bound to remain volatile. The comments from the organisation are a few months old but have been having an impact recently because they have been highlighted in the press. The Islamic banking community needs to formally address these issues and get investors comfortable,” said Abdul Kadir Hussain, CEO, Mashreq Capital. “No scholar has ever stated that their views would be applied retroactively. Certain scholars are merely expressing a view of how they would like sukuk to be structured, going forward.”

“We need to distinguish two types of activities: the primary issuance on the one side and the secondary market activity on the other side,” said Giambattista Atzeni, Mena Strategic Business Development Manager for Global Corporate Trust at The Bank of New York Mellon. “In relation to the primary issuance, we think that the future activity will be linked to the pace of adjustment towards Shariah-compliant true-sale securitisations type of transactions. These deals are fully asset-backed and they represent certificates of ownership against tangible assets.

“These assets are effectively sold and registered to the certificate-holders and therefore investors accept a true ‘profit and loss sharing’ formula. We also believe that convertible sukuk will continue to support the activity on the primary issuance side. In particular, certain convertible structures, which were not criticised by the organisation, will represent a solution to the ‘go public’ trend within the GCC,” said Atzeni.

“In relation to the secondary activity,” he continued, “as accepted true asset-backed structures can be traded in the secondary markets, this could have a positive effect on the future activity.”

Despite the positive outlook, Atzeni still had a word of caution to offer. “We may continue to experience a lack of liquidity caused by the credit crunch, the slow but eventual incorporation of accepted standards and a market infrastructure not fully capable to facilitate post-trading activity for these instruments,” he said. “Most sukuk will be purchased to hold until the market stabilises/ evolves,” he pointed out.

According to a recent report by Standard & Poor’s, some issuers may have reconsidered how they structure their sukuk as a result of the organisation ruling, resulting in delays. The report maintains that most sukuk were issued in markets where liquidity is still abundant and/or appetite for Shariah-compliant instruments is high – namely the countries of the GCC and Malaysia.

Despite lower issuance compared to last year, S&P expects sukuk issuance will reach $20bn to $25bn this year given the good pipeline. Nevertheless, the borrowing costs of sukuk have been rising and pricing, while still attractive, is now dearer than earlier.

According to a Bloomberg report, as demand for Islamic bonds waned, yields rose to 2.94 percentage points more than the London Interbank Offered Rate (Libor), near a record and compared with 2.43 percentage points for an equivalent non-Islamic bond. The spread was 1.08 percentage points a year ago and about double that in February.

“Sukuk are repricing now because base rates in relation to Eibor and Sibor have risen considerably over the last quarter – in Eibor’s case by 125bps,” explained Moini.

“This is indicative of local currency beginning to dry up that has been caused by the level of borrowing done year-to-date in local currency and the unwinding of long only UAE dirham/ Saudi riyal currency position in the expectation of a revaluation,” said Moini.

“It’s difficult to differentiate local and international investors, but sukuk prices have continued to come off, although some of that would be attributable to the market in general,” said Hussain. “At the end of the day investing is a risk appetite call, and no capital markets are immune from risk perceptions, Islamic or non-Islamic.”

“In a world where investors are becoming very risk averse, pricing for all securities will be impacted. What we are not likely to see in the Islamic space is the underlying credit weakness and rise in default risk that we are seeing elsewhere in global markets.”

“No market can remain insulated from global trends,” said Moini.

Atzeni agreed with their viewpoint.

“Within a globalised market, any instrument – whether Islamic or otherwise – would be affected by the financial squeeze.”

“In addition to liquidity tightening, credit default swaps have widened at a sovereign level. This is being caused by the global credit crunch, a surfeit of borrowing by local issuers, a concentration of issuers related to real estate and corporate governance issues. As credit default swap levels rise, the cash market for sukuk revises its pricing. Therefore, there are both capacity and credit related issues causing sukuk spreads to widen,” said Moini. “Traditionally, sukuk have been less liquid than conventional bonds so relatively small trades can significantly affect secondary market pricing. Therefore, we need to analyse secondary market trading volumes carefully,” he said.

All experts that Emirates Business spoke to were bullish on the medium- and long-term future of Islamic finance in general and sukuk in particular.

“The vast majority of investors on the primary side are represented by international investors and they are generally less vulnerable to these types of verdicts,” said Atzeni, referring to the organisation ruling. “International investors have a strong appetite in Middle Eastern corporates and are looking to gain more exposure in the GCC, therefore Sukuk represent a perfect solution for their investment needs. We expect a gradual pick up before the end of the year.”

“The organisation ruling must have added to the uncertainty, however, we must remember that sukuk tend to be tightly held and are mostly placed with regional investors (referring specifically to straight debt as opposed to convertible sukuk). The regional investor base obviously has greater insight into the market and the instrument,” said Moini, declining to predict the near-term volume.

Atzeni added: “We have reason to believe that Islamic products can potentially represent a solution or a safe harbour in these challenging times.”


Written by Suapi Shaffaii

October 6, 2008 at 8:07 pm

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